Chapter 5 - The Purpose and Use of Credit and Credit Instruments

Basis of credit | Classification of credit | Credit instruments | Negotiable instruments | Promissory notes | Bills of exchange Classification of drafts | Recommendations regarding use of credit instruments | Leases – definition basis of validity | types | contents and check points | Mortgages – definition | definition of terms deeds | major classifications | Check list of important considerations

Basis of Credit

The ability of an individual or firm to obtain credit depends on the prospective creditor's belief that the individual or firm will be able and willing to repay at some specified date in the future. The basis for credit then will depend on the debtor's ability to pay—the nature and value of his capital or present investment, his present and future in­come, the size and type of other claims and obligations; and on the debtor's willingness to pay—his character and reputation for honesty, business ability, and for prompt payment of past obligations.

Classification of Credit

Of the many classifications of credit that have been made, several categories are discussed in the following paragraphs. These classifica­tions are based on the length of time credit will be utilized, whether the credit is secured or unsecured, and whether credit is used to finance purchases of fixed assets for consumption or production purposes.

On the basis of the length of time credit is utilized, credit may be categorized as demand, short term, intermediate term, and long term. Credit that is given to a debtor and payable immediately or whenever the creditor demands payment is called payable-on-demand credit and represented by such instruments as government notes, commercial bank notes, or call loans.

Short term credit is any credit given to a debtor, the repayment of which is not on demand of the creditor but at a stated date that is less than a year later. A promissory note is a good example of this type of credit.

Intermediate term credit differs from long term credit in that the former applies to obligations running from one to five years and long term credit applies to any debt that runs for more than five years.

Since a borrower may obtain credit through a "character" loan or by pledging assets such as securities, cash values of insurance, or other assets having a determinable value, credit may properly be classified as secured or unsecured depending on whether or not an asset or in­come has been pledged to obtain a loan. In most instances, except for demand or short term debt, the new man in business must put up enough collateral to secure the debt.

The classification of credit according to the use of the money ob­tained may be described as either consumption and production credit or credit to finance current or fixed assets. On the basis of consump­tion or production the money is used for the purposes of obtaining either goods or services that will be utilized immediately (consump­tion) or is used to increase the productive activities of the business (production).

Credit used to finance current or fixed assets is self explanatory. In either case short term credit is generally used to finance the purchase of current assets, consumption of goods and services; and intermediate or long term credit is used to finance the purchase of fixed assets or production activities.

CREDIT INSTRUMENTS

Definition

A credit instrument may be defined as a legal document evidencing the existence and terms of a credit or debt contract. Credit instruments as defined in this paragraph will therefore include promissory notes, bills of exchange (checks, sight or demand drafts) leases and mort­gages.

Major Classification of Credit Instruments

A very important classification made of credit instruments is the distinction as to their negotiability or non-negotiability. This classifi­cation is vital, not because a credit instrument can or cannot be sold— all credit instruments can be sold-—but more important, whether title to the instrument is transferred by assignment or by endorsement.

When a title is transferred by assignment, the person accepting title to the instrument—the assignee—has no better right or title to the credit instrument than the title or right possessed by the assignor. There is no unconditional promise to pay in an assigned credit instru­ment.

On the other hand, when a title is transferred by endorsement, the holder of the instrument is protected by several special advantages con­ferred by the negotiable instruments law, including an unconditional promise of the debtor to pay.

Negotiable Instruments

Credit instruments whose titles are transferred by assignment are governed by the Uniform Negotiable Instruments law and are known as negotiable instruments.

The first important objective to be achieved is the development of an adequate understanding of the difference between a negotiable and a non-negotiable instrument. Because of the special privileges for holders of negotiable instruments, the kinds of instruments to which such privileges belong are strictly defined. Any instrument that doesn't conform to all the distinctions of a negotiable instrument will be gov­erned by other rules and not by the law of negotiable instruments.

Section I of the Uniform Negotiable Instruments law reads ... An instrument to be negotiable must conform to the following require­ments:

1.  It must be in writing and signed by the maker or drawer.

2.  It must contain an unconditional promise or order to pay a cer­tain sum of money.

3.  It must be payable on demand or at a fixed or determinable future date.

4.  It must be payable to the order of bearer.

5.  Where the instrument is addressed to a drawer, he must be named or otherwise indicated therein with reasonable certainty.

Note that all of these requirements must be met to make an instru­ment negotiable. However, an instrument is held to be in writing even though it is printed or typed and the amount to be paid under an instrument is a sum certain even though it is to be paid with interest in an unnamed amount. In contrast to these reasonable assumptions, a promise to pay thirty days after ... I sell the dishwashing machine . . . I receive my check ... or I sell the store ... is not an unconditional promise to pay. You may not receive the check, nor sell the machine or the store. An instrument, therefore, that is so conditioned is not negotiable.

Promissory Notes

Before the importance of negotiability or non-negotiability of credit instruments can be properly demonstrated, several illustrations and principles should be considered. Figure 1 below is a negotiable promis­sory note

Figure 1

A promissory note is a statement in writing made by one person to another and signed by the maker, promising to pay on sight or at some future date an amount of money to the bearer. Usually there are at least two parties to a promissory note, the maker and the payee. The payee may be bearer or a specified person.

If the promissory note contains: (1) an unconditional promise, (2) in writing, (3) to pay a certain sum of money (4) on demand or at a determinable time (5) to the bearer or to the order of a specified person, the note is negotiable. If any one of these conditions is not met, the note is non-negotiable.

Promissory notes, like other credit instruments, will of course vary considerably from one another. They will differ in such items as time of maturity, security, interest, and amount of money.

Bills of Exchange

In contrast to promissory notes, bank notes, bonds, bank deposits, and other credit instruments that are promises to pay, bills of exchange or drafts are orders to pay. Instruments such as checks, trade drafts, trade acceptances, and money orders are unconditional orders in writ­ing signed by the person giving the order, and requiring the person to whom the order is addressed to pay on demand or at a determinable time, a fixed sum of money, to bearer or to order.

Bills of exchange may be classified in several ways. Two important categories are based according to the type of person or firm who is ordered to pay and according to the amount of time elapsing before maturity date. To illustrate these classifications, an order on a bank to pay is a bank draft; to another type drawer, a trade draft; a draft ordering payment immediately or on demand is a sight draft or de­mand draft; an order to pay after a certain lapse of time is a time draft.

In most cases there are three parties to a draft: the drawer—the one who orders payment, the drawee—one who is ordered to pay, and the payee—the one who will receive the payment.

Figure 2

Figure 2 is familiar to everyone as a bank check. Because the chief use of a check is to transfer credit from one account to another, a check is also a credit instrument. In addition, because the check is (1) an order to pay (2) on sight and (3) the drawee is a bank, the check is known as a sight bank draft. If the draft were payable only after a certain lapse of time, the order is called a time bank draft or a time trade draft, depending on the drawee involved. Figure 3 illus­trates a time trade draft.

The basic difference between a promissory note and a bill of ex­change is that the first is an unconditional promise to pay and the second is an order to pay. If all the legal requirements are met, the promissory note is a negotiable credit instrument whereas the bill of exchange is not negotiable unless the order to pay is converted into a binding unconditional obligation to pay.

Figure 3

For example, the trade draft shown in Figure 3 can be converted into a negotiable credit instrument by the drawee accepting the order to pay. When the order to pay is "accepted," signed and dated, the trade draft is transferred into a trade acceptance that may be used over and over again in financing and trade.

To illustrate the practical uses of the trade draft, study the following situation connected with Figure 3. John Smith, a manufacturer of cash registers, receives an order for a cash register from the Depart­ment of Hotel and Restaurant Administration. The Department, how­ever, does not wish to pay for ninety days and Smith does not wish to surrender title to the register. The problem can be solved in this manner.

Smith ships the register to the department, consigning it to himself and receiving a bill of lading. The bill of lading, representing title to the register, is sent together with the draft to the local bank in Florida. The bank presents the draft to the Department for acceptance and then gives the Department the bill of lading so that it can claim the register.

The time trade draft is now a trade acceptance held for or by Smith. If he desires, he may keep it for ninety days or endorse it and sell the acceptance to a bank or any investor. The bank may resell the accept­ance to other investors and this may continue several times before the maturity date has elapsed.

Recommendations

A summary of important facts regarding the credit instruments de­scribed to this point will include the following material:

1. If you give credit, make sure that the debtor gives you an unconditional promise to pay.

2.  If you accept a promissory note or bill of exchange, see that it is negotiable.

3.  Remember, a credit instrument payable to bearer can be trans­ferred by mere delivery of the instrument, but an instrument payable to a person or his order can only be negotiated through delivery and endorsement. This means if you endorse a check in blank and a check is stolen or lost and is subsequently cashed at a store, there may be nothing you can do about it except find the original thief. The blanket endorsement makes the instrument payable to the bearer. If the owner of the store who cashed the check did so in good faith, he becomes the legal owner of the check.

4.  If you intend to transfer a check to your account, endorse it "For Deposit Only."

5.  Do not sign any uncompleted credit instruments. If an innocent purchaser of a negotiable instrument presents the instrument for pay­ment, the drawer will have a difficult time preventing the establishment of his liability.

6.  The words "I promise to pay" in an instrument signed by more than one person make the signers jointly and severally liable, exactly as though they had written "we."

7.  Regardless of the fact that you use an assumed name, trade name or any name, Section 18 of the Negotiable Instruments law provides that you cannot escape liability if your signature is on the instru­ment.

8.  An infant's promise on a negotiable instrument is not enforcible. If Jones, 18 years old, receives a check payable to his order or endorses a check as a drawer, the infant may be held liable for fraud if the endorsement or drawing is fraudulent. However, if his actions are not fraudulent, Jones is not liable as either endorser or drawer. A person receiving the check will not be able to recover from Jones unless he affirms his promise after majority.

9.  As a creditor you may accept a check for a lesser amount even though it is marked paid in full and still move to collect the balance, // there is no question as to the amount due. If there is a dispute over the amount due, however, return the check and sue. Acceptance of the check in this instance will usually liquidate the claim. The payee may not sue for any balance.

10. A maker of a check or a holder who negotiates a check are guilty of a crime if they know that there are insufficient funds or credit to meet it.

11. In most instances do not accept post-dated checks. A check properly dated is an implied presentation that the drawer has sufficient
funds on deposit to meet the presentation for payment. A postdated check is a mere promise to pay at some future date. Fraud is never presumed, but in this case must be proved by the payee.

12. All states have bad check laws designed to protect the payee. However, since most of these laws define the act as a misdemeanor or felony requiring criminal action, restaurant operators are cautioned not to call up or otherwise threaten the drawer of the check. Ask for information concerning the check without making threats. If a threat is made, the operator may be charged with a penal offense in some states or blackmail or extortion in others.

LEASES

If you have a 5-year lease and you continue doing business for 5 years and 1 day, how much rent will you owe the landlord? One day, 1 month, 1 year, 5 years? If the restaurant you are leasing burns down or is otherwise damaged to the extent that business is completely inter­rupted, are you required to continue lease payments? Common sense may probably tell you that you are required to pay only 1 day's rent or if you cannot open for business, you should not pay rent. The law and the small print on the lease, however, may say otherwise.

A lease is an agreement entered into between a lessor—the landlord —and a lessee—the tenant—conveying possession of property and certain rights from the lessor to the lessee. Note that a lease conveys a right to the possession and use of a property and not a title to the property.

Leases may be written or verbal, formal or informal. A valid lease is based on the intention of the parties and not on any particular word­ing or form. The important substance of a lease is the intent of the lessor and lessee and not the arrangement of words according to some preconceived form.

Elliot Hunt Marcus, attorney-aMaw, once stated,

"A lease is a technical document which has many meanings, a good many of which are in what is not said as well as the specific words themselves. You have no more right to sign a lease without first reading and understand­ing it than you have to compound a prescription for your ailing child." The greater the amount of money involved and the longer the term of the lease, the greater the reason for giving detailed attention to the rights and obligations of both parties of the lease and the greater the reason for obtain­ing the assistance of a qualified lawyer.

Types of Lease

Leases may be classified according to the terms of the lease, the duration, the property leased, and the method of rental payments.

Accordingly, a lease may be a contractual agreement to convey property and certain rights for 1 day, 1 month, 1 year, 10 years, or 999 years. Whether a lease is described as short term or long term will vary according to the type of property leased. For example, a 2-year lease for a restaurant may be considered short term and a 5-year lease, long term. On the other hand, a 5-year lease on a building may be considered a short term lease and a 1-year lease on an apartment as long term.

The basis of lease classification in another category is the property lease. For example, a ground lease is one made for the purposes of conveying possession of land only. The lease usually contains provisions regarding the erection of a building on the land and the disposition of the building at the end of the lease.

Most restaurant operators are familiar with other types of property leases such as a building or an equipment lease. The building lease is very often more complicated than a ground or equipment lease. Since the lessor conveys possession of both land and building, he must con­sider and clearly define his and the lessee's rights and obligations during the term of the lease.

The periodic return paid by the lessor to the lessee is called rent. If the amount to be paid continues at a uniform rate throughout the term of the lease, the lease is called a straight or fixed rental lease. If the lease is graduated upward, it is called a graded lease or gradu­ated rental lease.

Another type of lease based on the manner of rental payments is the percentage lease. In this case the lessee agrees to pay rent according to a percentage of sales or he may pay a minimum fixed sum plus a percentage of sales. The specific provisions regarding payment in the percentage lease will very often depend on the lessor's appraisal of the lessee. If he believes that the lessee is an efficient manager or operator, he will usually prefer a lease based on a higher percentage of sales. On the other hand, if he believes that the manager is capable but not extremely so, the lessor will protect his investment by requiring the lessee to pay a relatively high minimum fixed rate and a correspond­ingly low percentage rate.

A reappraisal lease is one in which the lessee is asked to pay fixed or graduated rent for a short terrri after which the amount of rent is increased or decreased according to a determination based on a re­appraisal of the property.

Contents of Leases

With the aid of a qualified lawyer the prospective tenant should give detailed attention to the following subjects:

1. Are both the landlord'and tenant legally competent to enter a contractual relationship?

2.  What is the basis for rental payments? This should be clearly defined so that there is no misunderstanding.

3.  Is subletting or assignment prohibited or permitted? If a clause is inserted in the lease that tenant cannot sublet or assign without the written consent of the landlord, the addition of ". . . and the landlord shall not unreasonably withhold his consent. . ." protects the lessee in that the landlord must grant permission unless prospective assignee is not financially responsible.

An assignment is a complete transfer of rights and terms of lease from one tenant to another. The rule is that once a lease has been assigned with the landlord's implied or expressed consent, a lease is thereafter freely assignable. The original lessee is cautioned, however, that even though a lease has been properly assigned, he can still be held personally responsible for the rent.

The term sublet creates a relationship in which a new lease is made and the old tenant becomes a lessor and the new tenant a lessee. If the owner of the property insists on controlling the- type and charactei of his occupancies, he usually provides in the lease that there shall be no subletting without the landlord's consent.

Since a good lease is personal property, it can be a valuable asset assignable at a profit. The prospective tenant should study the clause relating to subletting and assignment very carefully.

4.  The term of the lease should be established beyond doubt.

5.  Ordinarily trade fixtures such as shelving, counters, and display cases are removable by the lessee. To prevent misunderstanding, see that a clause is in the lease describing the disposition of fixtures during or at the termination of the lease.

6.  Most improvements become the property of the landlord when made. It is proper, however, in some cases to provide that some or all improvements be removed prior to the expiration of the lease.

7.  Check lease to see if the lessee remains in possession if the lessor should die or the government step in.

8.  In some circumstances an option to purchase should be con­sidered very carefully. One of the basic disadvantages of leasing is that the tenant can never build up ownership equity in the business.

9. Check options to renew. An option is a prior right to do something—a contract to keep an offer open. In the case of an option to renew, the right is exercised within a stated period prior to the expira­tion of the lease. A so-called automatic renewal usually gives either party the right not to renew. Check the terms of the renewal. How long a period is the renewal, at what price, under what conditions?

10. Usually in the absence of written restrictions, a tenant may use the premises in any legal manner. The tenant's use of the property is subject to the rule that he may not do anything expressly forbidden by the law or in such a manner as to injure or unnecessarily diminish the value of the property. Illegal use of the premises would permit an action for dispossession by the landlord.

11. If the landlord requires the tenant to furnish security for the performance of the terms of the lease, check amount and type of secu­rity requested. The amount of security may be a sum equal to the rent for 2 months or 1 or more years depending on the term of the lease. If a cash deposit is required, very often an agreement is reached that the tenant shall receive interest on the money deposited.

Generally, cash deposits should be avoided because the cash is not tax-deductible until the owner accepts it as part of the rent. On a long term basis, therefore, a cash pledge or its equivalent reduces working capital and provides no income tax benefits.

The terms of the lease should specify what disposition shall be made of the deposit if the landlord sells his interest in the property while he has the money or securities on deposit. Usually the lessor is per­sonally responsible for the deposit.

12. Check provisions regarding repairs, taxes and other obliga­tions of the lessor and lessee.

(a) If the lease does not require the lessor to keep the property in good condition, he has no obligation.

(b) If the lease makes an allocation of repairs to both parties, for example, the landlord to be liable for exterior repairs and the lessee for interior repairs; see that the type of repairs, conditions under which they must be made, and the remedy for failure to repair is carefully spelled out.

(c) If a lease contains a tax participation clause, the clause should definitely state the type of taxes to be paid by each party.

(d) In several states the law provides that a fire which renders the premises untenable, the lease is automatically termi­nated. If there is no such provision of law, the lease of the premises continues. Generally it is advisable to include a clause in the lease so that in the event of fire, the lease is automatically cancelled.

(e) Check all special covenants for additional charges. These charges may include water, heat, insurance, and other items. You will want to know the extent of your liability, and the exact value of the services that are to be rendered because of your acceptance of these charges. In cases where the lessee is expected to pay in addition to an agreed rental the expenses of taxes, insurance, interior repairs, water, heat and other charges, the rent paid to the lessor is called the net rental.

13. Generally a lessor may terminate the lease and dispossess the tenant for the following reasons:

(a) Unlawful use of the premises

(b) Non-payment of rent, or other charges such as taxes, insur­ance which were agreed to according to the provisions of the lease

(c) Bankruptcy proceedings

(d) Expiration of term of lease

In addition the lessor may wish to protect his investment by insert­ing clauses that will cancel the lease if he sells or demolishes the build­ing, or for any other expressed reason. The lease should be carefully studied so that the long range interests of the lessee and lessor are protected. The rights of both parties and a complete description of the conditions under which a lease is terminated or cancelled should be carefully defined in the lease.

MORTGAGES

Mortgages have been used from early times to borrow money by property owners. A mortgage is a legal document creating a claim against real property under which, in case of default, the lender may proceed to collect from the property. Before a detailed discussion of mortgages can be made, the reader should acquaint himself with the following terms:

1. Property is the right or interest of an individual in anything subject to ownership.

(a) Real property is the right or interest held in land, buildings, or those items growing, erected or annexed to the land.

(b) Personal property is the rights or interest held in any item of goods that is not classified as real property.

(c) Fixtures are property that can change from real to personal or vice versa. If they are definitely fixed to the land, the items are known as real fixtures. If the fixture is not annexed or used with the land or real property, it is known as chattel fixtures.

An article is or is not a real fixture depending on the intent of the person, the method of annexation and the relation of the parties. If he attaches the property to a building with the idea of making it a perma­nent part of the building, the property becomes a real fixture. If the property is annexed to a building in such a way that there would be a substantial loss to real property or if it is especially adapted for use where it is placed and if removing it would leave the building or land incomplete, it is a real fixture. Finally, in the relation of parties, for example, a landlord and tenant relation, a tenant may be ordinarily bound to leave property which he has fastened to a building. The general rule in this relation, however, states that certain property such as showcases, shelves, and counters are not real fixtures for the tenant has the right to equip himself with and retain the tools of his trade.

2. Estate is the right or interest a person holds in the land. There are three major types of estate:

(a) In the inheritance estate, the interest passes on to the heirs.

(b) In a life estate, the rights or interest to the land is held only for the life of the individual holding the life estate.

(c) An estate in fee simple is an absolute estate in which the owner can do anything he wants with the land. The words in a deed, "grant and release unto the party of the second part, his heirs and assigns forever' create the fee simple grant. The words, "grant and release to _______________ for life" create the life estate.

(d) Other estates are dower, courtesy, fee upon condition, fee determinable, and remainders. A dower is the estate for life given by law to a wife in all real property owned by her husband during marriage. A courtesy is the estate given to the husband in real property owned by the wife.

In both the fee upon condition and fee determinable the holder has an estate in fee simple. This estate differs from the absolute state only in the limitation that if a certain condition occurs (fee upon condition) or when a foreseeable and determinable contingency arises (fee deter­minable) the rights to the estate will pass from the holder to another.

The remainder estate is invariably associated with the life estate. In this type of estate the interest to real property is given to one person for life and at his death the estate is to pass on to a remainderman.

3. A deed is a legal document which conveys title to real property. There are various types of statutory and nonstatutory deeds; however, the restaurant operator will usually be interested in the following three deeds:

(a) Quit Claim Deed. The words, "Remise, release and quit claim," in the granting clause create the quit claim deed. In using these words the grantor transfers his rights, // any, to the property to the grantee. There is no implication that the grantor has good title.

(b) Bargain and Sale Deed. The words "grant and release" in the granting clause create the bargain and sale deed. Whether the deed contains or does not contain a written promise, the grantor of this type of deed impliedly asserts that he has possession of the property and substantial title.

(c) Warrantee Deed. In this type of deed the grantor warrants that he has good and marketable title to the property. He usually will give the grantee every possible guarantee in a deed containing six covenants:

1.  Seizin. Under this promise the grantor guarantees that he owns, possesses and has a right to sell the property.

2.  Quiet Enjoyment. This promise guarantees that the purchaser shall not be disturbed in the possession of his property.

3.  Further Assurance. By this covenant the grantor is required to perform such acts as necessary to perfect the title in the grantee.

4.  Encumbrance. This covenant guarantees that the premises are free of liens except those mentioned in the deed.

5.  Warrantee Forever. This covenant guarantees both possession and title to the premises. The promise is an absolute guarantee by the grantor and if broken, the grantee may recover damages up to the value of the property at the time of sale.

6.  Trust. This provision reads that the grantor will hold money he receives from purchase of the property in trust for payment of any improvements that he made prior to the sale of the property unless all liens were known to the grantee and agreed on previously.

There are three major classifications of mortgages. The bases for the various classifications are the risk of the loan, the method of pay­ment and the type of mortgage.

Risk of Loan

Conventional—the loan is uninsured and not guaranteed.

F.H.A.—the F.H.A. loan is insured.

V.A. or G.I.—the Veterans Administration guarantees a certain percentage of the loan up to a maximum amount of $7,500.

Method of Payment

Term Mortgages—In this type of mortgage the interest is paid periodically and the principal debt is payable in full at the end of a designated period of time. There are two types of term mortgages:

(a) Open mortgages are term mortgages which upon maturity were not extended. These mortgages are past due and payable on demand.

(b) Closed mortgages are unexpired term mortgages which are not in default. The usual application of this term signifies that the last payment on the mortgage has been made.

Amortizing Mortgages—These mortgages have provisions for peri­odic amortization of the principal debt. Periodic payments include payment of principal as well as interest. The two basic amortizing mortgages are known as the constant mortgage plan and the straight principal reduction plan. Under the constant payment plan the periodic payments remain the same throughout the term of the mortgage. The periodic payments are allocated to interest and principal on a varying basis. Under the principal reduction plan the periodic payments are gradually reduced throughout the term of the mortgage. Each payment reduces the principal by a fixed sum and the remainder of the payment pays interest on the reducing principal debt balance.

Types of Mortgages

There are many types of mortgages available to the builder or prop­erty owner of a restaurant. Each type meets the specific needs of the mortgagee and is named according to the specific features that it pos­sesses. Of the many types available the most commonly used by res­taurant operators are the following:

(1) Purchase Money Mortgage—The distinguishing feature of this type of mortgage is that it secures part of the selling price for the purchaser of the property. Many times the purchaser of a property may not wish or cannot pay cash for the real estate involved. A contract of sale is drawn up stipulating that the purchaser will give a mortgage on the property for an agreed amount and that the seller will accept the mortgage as part of the consideration. This mortgage is superior to all other liens against the purchaser which may at any time attach to the real estate purchased.

(2) Package Mortgage—To eliminate many short term burdensome financial requirements to pay for such items as heating, cooling and cooking equipment, the purchaser of a restaurant may very well consider the financing of real estate and the necessary fixtures by means of a package mortgage. The package mortgage as its name implies finances the entire package in one mortgage and by spreading out a series of payments for equipment and fixtures over the entire life of the mortgage protects the restaurant owner's working capital and enables him to better meet financial emergencies that usually arise during the first three years of operation.

(3) Open End Mortgage—The open end mortgage is one which permits the operator to obtain additional advances from the lender up to but not exceeding the original amount of the mortgage. This type of mortgage is advantageous to the bor­rower because of the relatively low interest rate and the longer loan period. For example, to finance the remodeling of a dining room, the purchase of heavy equipment, the installation and purchase of central air-conditioning, the owner of a closed end mortgage may find it necessary to borrow money from credit sources over a short term period and at a high interest rate.

(4) Construction Mortgage—The basic purpose of the construction mortgage is to finance the erection of a building. Generally a loan contract is drawn, incorporated in a mortgage or re­corded separately in addition to the mortgage, specifying that the amount of the loan will not be paid in full but shall be advanced to the borrower in installments during the construc­tion of the building and will be repaid to the lender when the building has been completed.

There are many points that should be checked by you and a com­petent lawyer before and during the mortgage closing. Some of the important items that should be considered include the following:

1.  Leases and mortgages are not negotiable credit instruments. A lease is transferred by assignment of a lessee; a mortgage, by assignment of the creditor.

2.  Insist on a clause reading: "risk of loss or damage to said prem­ises is hereby assumed by the seller until the delivery of the deed."

3.  See that the purchase contract does not contain a clause stating that any down payment made will be treated as liquidating damages. If a purchase contract contains this clause, is signed by you, and for some business purpose you decide not to purchase, you will not recover your money.

4.  Check on all restrictive covenants in the mortgage. For example, if you are limited to two stories and you build three, you are subject to legal action. In most mortgages you must expect to promise that
you will pay what you owe, according to the provisions of the mort­gage, to keep the property insured, not to alter, demolish, remove real property without consent and to pay all taxes and assessments.

5.  Check for "sleeper clauses" such as, "the mortgagee may declare the full amount of the mortgage due and payable any time after the mortgage has been in effect for 2 years."

6.  If for business reasons you desire to take possession at a certain date, insert time is of the essence clause. Delivery of deed must be made on or before the specified date. You may also insert "in the event the seller fails to deliver possession of premises at time of delivery, it is hereby agreed that the seller shall pay  __________ "

7.  Carefully spell out any contingencies. If the purchase transac­tion is to be subject to obtaining a G.I. loan of $7,000 at 4.5percent, the contract to purchase should state this categorically. Do not say "subject to obtaining a loan of $7,000" or "subject to obtaining a G.I. loan" or "subject to obtaining a G.I. loan of $7,000." State that
this purchase contract is "subject to obtaining a G.I. loan of $7,000 at 4.5percent."

8.  Check to see the mortgage does not contain a clause prohibiting sale of the property without the consent of the mortgagee. If the mort­gage contains this clause, and a sale is consummated, the entire amount of the mortgage may become due immediately.

9. Study the details of the receiver clause. Generally, this clause enables the mortgagee to appoint a receiver during an action to fore­close. The receiver replaces the owner of the restaurant or other property, collects sales, pays expenses, and retains the profits for the mortgagee.

10. A foreclosure by action of law is slow and very often expen­sive. Check the mortgage for details regarding who will pay the lawyer and other fees in case of foreclosure.

11. Check the personal property clause. All personal property that is mortgaged to the mortgagee, granted and released or otherwise included as a pledge for performance creates a conditional transfer of title. In the event of foreclosure, all property pledged as part of the security is included in the sale. Note also if, after acquired, personal property is subject to lien of mortgagor.

The study of credit and credit instruments is manifestly complex. The primary purpose of this chapter is to provide the reader with basic fundamentals necessary to prevent serious misunderstandings and un­necessary financial complications that will result in ultimate loss. The selection, use, analysis, and protective features of negotiable credit instruments, leases, and mortgages requires specialized training and a wealth of adequate experience in the field of law, management, and finance. The secondary objective of this chapter is the demonstration of the practical value of obtaining qualified seasoned advice, before and not after an action has been consummated.

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